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2
SUPPLY AND DEMAND
_______________________________________________________________________
CHAPTER OUTLINE
Supply and Demand Defined
The Supply and Demand Model
All about Demand
All about Supply
Determinants of Demand
Determinants of Supply
The Effect of Changes in Price Expectations on the Supply and Demand Model
Kick It Up a Notch: Why the New Equilibrium?
Summary
LEARNING OBJECTIVES
LO1: Illustrate and explain the economic model of supply and demand.
LO2: Define many terms, including supply, demand, quantity supplied, and quantity demanded.
LO3: Utilize the intuition behind the supply and demand relationships as well as the variables that can change
these relationships to manipulate the supply and demand model.
KEY TERMS
Supply and demand- the name of the most important model in all of economics.
Price- the amount of money that must be paid for a unit of output.
Output- the good or service produced for sale.
Market- any mechanism by which buyers and sellers negotiate an exchange.
Consumers- people in a market who want to exchange money for goods or services.
Producers- people in a market who want to exchange goods or services for money.
Equilibrium price- the price at which no consumers wish they could have purchased more goods at the price; no
producers wish that they could have sold more.
Equilibrium quantity- the amount of output exchanged at the equilibrium price.
2
Chapter 2
Quantity demanded- the amount consumers are willing and able to buy at a particular price during a particular
period of time.
Quantity supplied- the amount firms are willing and able to sell at a particular price during a particular period of
time.
Ceteris paribus- Latin for all things equal.
Demand- the relationship between price and quantity demanded, ceteris paribus.
Supply- the relationship between price and quantity supplied, ceteris paribus.
Demand schedule- presentation, in tabular form, of the price and quantity demanded for a good.
Supply schedule- presentation, in tabular form, of the price and quantity supplied for a good.
Equilibrium- the point where the amount consumers want to buy and the amount that firms want to sell are the
same. This occurs where the supply curve and demand curved cross.
Shortage- the condition where firms do not want to sell as many goods as consumers want to buy.
Surplus- the condition where firms want to sell more good than consumers want to buy.
Excess demand- another term for shortage.
Excess supply- another term for surplus.
Law of demand- the statement that the relationship between price and quantity demanded is a negative or inverse
one.
Substitution effect- purchase of less of a product than originally wanted when its price is high because a lower
priced product is available.
Real-balances effect- when a price increases, your buying power is decreased, causing you to buy less.
Marginal utility- the amount of extra happiness that people get from an additional unit of consumption.
Law of diminishing marginal utility- the amount of additional happiness that you get from an additional unit of
consumption falls with each additional unit.
Law of supply- the statement that there is a positive relationship between price and quantity supplied.
Price gouging- the pejorative term applied to the circumstance when firms raise prices substantially when
demand increases unexpectedly.
Price ceiling- the level above which a price may not rise.
Price floor- the price below which a commodity may not sell.
Supply and Demand
PROBLEMS
1. Select from the following two events:
(1) A shift in demand
(2) A change in the quantity demanded
Indicate which event will result from:
a. A change in a non-price determinant of demand. ___________________________________________
b. A change in the price of the product itself. ________________________________________________
Select from the following two events:
(3) A shift in supply
(4) A change in the quantity supplied
Indicate which event will result from:
c. A change in a non-price determinant of supply. ____________________________________________
d. A change in the price of the product itself. ________________________________________________
3
4
Chapter 2
2. What will be the effects of the following events?
For a through j indicate:
i. Curve Shift — The Effect on the Demand and/or Supply of a Product.
Select from: D increases (D ), D decreases (D ), S increases (S ), or S decreases (S ).
ii. Price Change — The Change in the Equilibrium Price.
Select from: Price increases (P ), Price decreases (P ), or Price is indeterminate (P ?).
iii. Quantity Change — The Change in the Equilibrium Quantity.
Select from: Quantity increases (Q ), Quantity decreases (Q ), or Quantity is indeterminate (Q
?).
Curve Shift
a. An improvement in technology.
Price Change
Quantity Change
_________
P ______
Q ______
b. A decrease in the size of the population of consumers. _________
P ______
Q ______
c. The price of a substitute good increases.
_________
P ______
Q ______
e. The resource prices of the inputs increase.
_________
P ______
Q ______
e. The good is a normal good, and the income increases. _________
P ______
Q ______
f. The number of sellers increase.
_________
P ______
Q ______
g. The price of a complementary good increases.
_________
P ______
Q ______
h. The good is an inferior good, and income increases.
_________
P ______
Q ______
i. There is a favorable change in taste.
_________
P ______
Q ______
j.
_________
P ______
Q ______
The price of the product is expected to increase.
k. The price of another product that the producer could potentially produce increases.
_________
P ______
Q ______
Supply and Demand
3.
5
Plot the data from the demand and supply schedules on the chart and complete the surplus/shortage column.
THE DEMAND AND SUPPLY OF RYE PER MONTH
______________________________________________________________________________________________________________________
Price Per Bushel
$0.75
1.00
1.25
1.50
1.75
2.00
Quantity Demanded
(Thousands of bushels)
32
27
22
17
12
7
Quantity Supplied
(Thousands of bushels)
(Qs – Qd)
(+)Surplus
or (-) Shortage
________
________
________
________
________
________
8
11
14
17
20
23
______________________________________________________________________________________________________________________
THE DEMAND AND SUPPLY OF RYE PER MONTH
Price
0
___________________
(Quantity / Time)
a. What is the equilibrium price?_____________________ Label the equilibrium price, Pe, on the graph.
b. What is the equilibrium quantity?__________________ Label the equilibrium quantity, Qe, on the graph.
c. What would happen if the price were $1.00 per bushel?
_____________________________________________________________________________________
d. What would happen if the price were $2.00 per bushel?
_____________________________________________________________________________________
6
Chapter 2
4. Illustrate the shifts in demand and supply. Draw the new curve, and note the new equilibrium price and
quantity.
a.
An Increase in Demand
b.
Price
A Decrease in Supply
Price
S1
P1
S1
P1
_ _ _ _ _ _ _ _ _ _ _
|
|
|
|
|
Q1
0
D1
Q/t
_ _ _ _ _ _ _ _ _ _ _
|
|
|
D1
|
_______________|______________
0
Q1
Q/t
Show the simultaneous shifts in demand and supply. Note the new equilibrium values on the diagrams below.
(In order to illustrate the indeterminacy of a variable, draw the diagram so that the indeterminate variable does
not change from its original level. Any variable, which can remain at the original level following a shift in
both demand and supply, must be experiencing upward and downward pressures (that just happen to cancel
out each other). Therefore, the direction of the change in the variable is indeterminate. It will depend upon
whether the shift in demand or the shift in supply dominates in this case.)
c.
An Increase in Demand and
An Increase in Supply
d.
Price
A Decrease in Demand and
An Increase in Supply
Price
S1
P1
0
S1
P1
_ _ _ _ _ _ _ _ _ _ _
|
|
|
|
|
Q1
D1
Q/t
_ _ _ _ _ _ _ _ _ _ _
|
|
|
D1
|
_______________|______________
0
Q1
Q/t
5. Name the three reasons that explain why demand curves are downward sloping to the left.
Supply and Demand
7
SELF TEST --- MULTIPLE-CHOICE QUESTIONS
1. If the Qd = Qs in the market, there is
a. an excess supply.
b. a shortage.
c. an equilibrium.
d. an excess demand.
2. If the Qs > Qd in the market, there is
a. an excess supply.
b. a shortage.
c. an equilibrium.
d. an excess demand.
3. If the Qd > Qs in the market, there is
a. an excess supply.
b. a shortage.
c. an equilibrium.
d. a surplus.
4. If the price of a product decreases,
a. the quantity supplied increases.
b. the quantity demanded increases.
c. the demand increases.
d. the supply increases.
5. Jennifer loves good coffee and buys a cup every morning before class. She buys just one cup, because
she thinks that a second cup of coffee is simply not worth the price that they charge at the school’s coffee
bar. This is an example of:
a. the law of supply.
b. the substitution effect.
c. an inferior good.
d. the law of diminishing marginal utility.
6. Chicken and beef are considered
a. inferior goods.
b. complements.
c. substitutes.
d. independent and unrelated to one another.
7. If the price of beef increased, we would expect to see:
a. demand for chicken decreasing, and as a result, the price of chicken falling in the market.
b. demand for chicken decreasing, and as a result, the price of chicken rising in the market.
c. demand for chicken increasing, and as a result, the price of chicken falling in the market.
d. demand for chicken increasing, and as a result, the price of chicken rising in the market.
8
Chapter 2
8. The supply of a product has decreased. This could have been caused by
a. an increase in the price of the inputs.
b. an improvement in technology.
c. an increase in the number of sellers.
d. a decrease in the price of another product that the sellers have the potential to produce.
9. As incomes in the region increase due to economic growth,
a. the demand for an inferior good will decrease and its price will fall.
b. the demand for an inferior good will increase and its price will rise.
c. the demand for a normal good will decrease and its price will fall.
d. the demand for a normal good will decrease and its price will rise.
10. The demand for a product increases, and at the same time the supply decreases,
a. the equilibrium price will fall, and equilibrium quantity is indeterminate.
b. the equilibrium price will rise, and equilibrium quantity is indeterminate.
c. the equilibrium price is indeterminate, and equilibrium quantity will fall.
d. the equilibrium price is indeterminate, and equilibrium quantity will rise.
11. All of the factors below explain the negative relationship between price and quantity demanded, except
a. the substitution effect.
b. the marginal cost effect.
c. the income effect.
d. the law of diminishing marginal utility.
12. Which of the following would not change the supply curve of cars?
a. an improvement in technology
b. a decrease in the number of foreign manufactures in the United States
c. an increase in the price of cars
d. an increase in the price of sport utility vehicles
13. The law of supply indicates that
a. the supply curve is negatively related to price.
b. producers will sell more of a good if consumers demand more of that good.
c. there is a positive relationship between price and quantity supplied.
d. the supply curve is downward sloping.
14. All of the following will result in a leftward shift of the supply curve, except
a. an increase in the price of inputs.
b. a decrease in the number of sellers.
c. a decrease in expected future price.
d. an improvement in technology.
15. An increase in the expected future price will
a. decrease equilibrium price.
b. shift the supply curve to the left.
c. shift the supply curve to the right.
d. shift the demand curve to the right.
Supply and Demand
Use the diagram below to answer Questions 16 to 19.
Price
S
$12.00 - - - - - - - - - - - - - - - - 8.00 _ _ _ _ _ _ _ _ _
|
|
|
4.00 - - - - - - - - - - - - - - - D
|
|
0
80
120
160
Quantity
16. The equilibrium price and quantity in this market are, respectively,
a. $12 and 80 units.
b. $12 and 160 units.
c. $8 and 120 units.
d. $4 and 160 units.
17. At a price of $12 there is
a. a surplus of 40 units.
b. a shortage of 40 units.
c. a surplus of 80 units.
d. a surplus of 120 units.
18. At a price of $4 there is
a. a surplus of 80 units.
b. a shortage of 80 units.
c. a shortage of 40 units.
d. a surplus of 120 units.
19. At the equilibrium price, the total expenditure by consumers is
a. $1,600.
b. $960.
c. $640.
d. $1,920.
20. If the government imposes a price ceiling on a product that is below the free-market equilibrium price,
a. a shortage will develop.
b. a surplus will develop.
c. the quantity supplied will be greater than the quantity demanded.
d. none of the above.
9
10
Chapter 2
21. Which government action below would be most effective in discouraging the use of firearms?
a. a tax on ammunition
b. a subsidy for firearms
c. an excise tax on steel and lead
d. regulate ownership of firearms
22. Which of the following items represents a government subsidy to students at a state university?
a. tuition received by the university
b. gifts and donations received by the university
c. state appropriations received by the university
d. money students spend on dormitories
Supply and Demand
11
SELF TEST --- TRUE / FALSE QUESTIONS
T
F
1. When there is a surplus in the market, the price will rise.
T
F
2. The law of demand states that there is an inverse relationship between the price and the quantity
demanded.
T
F
3. When there is a shortage in the market, the price will rise.
T
F
4. The substitution effect refers to the fact that when a price increases it decreases your buying
power, causing you to buy less of that good.
T
F
5. Consuming the third soda gives you more marginal utility than consuming the second soda.
T
F
6. The law of supply indicates that there is a positive relationship between price and quantity
supplied.
T
F
7. If you buy less of a good when you have less income, the good is called an inferior good.
T
F
8. A DVD and a DVD player are considered substitutes.
T
F
9. An increase in the price of a substitute good usually means that you will buy more of the
original good.
T
F
10. If there is an improvement in technology, the price of the good will fall, ceteris paribus.
12
Chapter 2
ANSWERS TO STUDY QUESTIONS
PROBLEMS
1. a.
b.
c.
d.
(1) A shift in demand
(2) A change in the quantity demanded
(3) A shift in supply
(4) A change in the quantity supplied
2. a.
b.
c.
d.
e.
f.
S,
D,
D,
S,
D,
S,
P, and
P, and
P, and
P, and
P, and
P, and
Q
Q
Q
Q
Q
Q
g.
h.
i.
j.
k.
D, P, and Q
D, P, and Q
D, P, and Q
D and S, P, and Q?
S, P, and Q
3.
THE DEMAND AND SUPPLY OF RYE PER MONTH
______________________________________________________________________________________________________________________
Price Per Bushel
Quantity Demanded
(Thousands of bushels)
$0.75
1.00
1.25
1.50
1.75
2.00
Quantity Supplied
(Thousands of bushels)
32
27
22
17
12
7
8
11
14
17
20
23
(Qs – Qd)
(+)Surplus
or (-) Shortage
-24
-16
-8
0
8
16
______________________________________________________________________________________________________________________
THE DEMAND AND SUPPLY OF RYE
$2.00
S
Price
$1.50
$1.00
D
$0.50
$0.00
0
4
8
12
16
20
24
Thousands of Bushels/Month
28
32
Supply and Demand
a.
b.
c.
d.
$1.50
17
There would be a shortage of 16 thousand bushels.
There would be a surplus of 16 thousand bushels.
4.
a.
Price
An Increase in Demand
b. A Decrease in Supply
Price
S2
S1
P2
P2
P1
_ _ _ _ __ _ _ _ _ _ _ _
_ _ _ _ _ _ __ _ _ _
|
|
|
|
|
Q1
0
c.
|
|
|
|
|
|
Q2
D2
D1
Q/t
_ _ _ _ _ __
An Increase in Demand and
An Increase in Supply
d.
Price
S1
|
P1 _ _ _ _ _ _ | _ _ _ _ _ _
|
|
|
|
|
|
D1
|
|
_____________________________
0
Q2
Q1
Q/t
A Decrease in Demand and
An Increase in Supply
Price
S1
S2
S1
S2
P1
0
P1
_ _ _ _ _ _ _ ___ ____ _ _
|
|
|
|
|
Q1
|
|
|
| D1
|
Q2
D2
Q/t
_ _ _ _ _ _ _ _ _ _ _
|
|
P2 _ _ _ _ _ _ _ _ _ _ _ |
D1
|
D2
_______________|______________
0
Q1
Q/t
5. Demand curves are downward sloping due to the (1) substitution effect, (2) real-balance effect, and (3) law
of diminishing marginal utility.
13
14
Chapter 2
MULTIPLE-CHOICE QUESTIONS
1.
2.
3.
4.
5.
C
A
B
B
D
6.
7.
8.
9.
10.
C
D
A
A
B
TRUE / FALSE QUESTIONS
1.
2.
3.
4.
5.
F
T
T
F
F
6.
7.
8.
9.
10.
T
F
F
T
T
11.
12.
13.
14.
15.
B
C
C
D
C
16.
17.
18.
19.
20.
C
C
B
B
A
21. A
22. C
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